Q&A: Ballooning Mortgages

Q My co-op has a balloon mortgage that will burst in approximately 5-6 years if not refinanced. We were told that the lender will not allow a refinancing for at least another year, if not longer, and has refused to do one for the past 2-4 years. How can this be legal?

-Concerned Shareholder

A According to Stephen Beer, an accountant with the New York-based accounting firm Czarnowski & Beer, “As I am an accountant, not an attorney, I can’t comment on what’s legal or not. The mortgages which cooperatives obtain are commercial mortgages and quite different from the residential mortgages many of us have on our residences. One important difference is that individuals can generally refinance any time without penalty. For cooperatives, refinancing without penalty can generally only occur within the last few months of the mortgage or when the interest on the building’s mortgage is substantially less than current rates. In essence, if the cooperative will have to pay a significantly higher interest rate, the mortgage holder will be happy to let them out of the old mortgage as they can reinvest the payoff proceeds into another mortgage, either with the building or another, at a higher interest rate.

“During the past several years, interest rates have been at historic lows, so the opposite is true. The mortgage holder is an investor who would receive less of a return if the mortgage is paid off and they reinvest the proceeds at lower interest rates. So commercial mortgages carry a pre-payment penalty or lock out period to protect the investor. I assume a lock out period is in place in your building’s case. That is unfortunate but common. Certain lenders are locking interest rates up to one year in advance of the end of lock out periods to ensure you refinance with them.

“As far as the balloon bursting, I would like you to consider the differences between an individual family’s life cycle and a cooperative building. Generally, debt is at its highest percentage of income in a young family. This debt normally declines and often disappears as the children have grown and the mortgage is fully amortized generally prior to retirement. The building has a perpetual life and has a limited interest in becoming debt free. Many unit owners expect the tax deduction that the mortgage offers and prefer not to pay maintenance charges necessary to amortize the mortgage any earlier than the lender requires. They want the lowest monthly charges with the highest percentage of deductibility. There are other owners who would prefer to plan to pay down their apartment debt to increase the future value but they seem to be in the minority.

“So the debt on most buildings is generally refinanced at each maturity. The risk is the interest rate at that time may be significantly higher and the unit owners will have a steep maintenance increase to pay the higher interest. With rising real estate values, many cooperative buildings actually take on more debt when reserves are diminished or significant work needs to be done on the building. In all these cases, there is usually only one place for the money to come from to pay the bills: the unit owners.

“From your question, it appears that your cooperative is not in a unique situation and unfortunately it appears most likely that the cooperative will not be able to refinance early at today’s low interest rates.”

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